Economics Chapter 1: Introduction to Economics and Demand Analysis

Introduction to Economics and Demand Analysis

• Economics is the study of production, distribution, and consumption, divided into two broad areas: microeconomics and macroeconomics.
• Microeconomics deals with individual economic units, including consumers and firms.

Demand Analysis

Law of Demand

• As the price of a good rises, buyers will choose to buy less of it (ceteris paribus).
• Conversely, as the price falls, buyers will buy more.

Demand Function

• The demand function expresses the demand for a particular good as a function of multiple variables.
• Key variables influencing demand include the price of the good, income levels, and the prices of other goods.

Example: Demand for Chairs

• Demand function: Q = 10 - 0.5P + 0.06I - 0.01Pt
• Q: quantity of chairs demanded
• P: own price of chairs
• I: average income level
• Pt: average price of tables

Inverse Demand Function

• Can be expressed as: P = 200 - 2Q
• Plotted on a graph, the demand curve shows the highest quantity consumers are willing to purchase at each price.

Elasticity of Demand

• Measures how the quantity of a good demanded responds to changes in its own price, holding other factors constant.
• Formula: ε = (ΔQ/Q) / (ΔP/P)
• For the example demand function, ε = -0.5(P/Q)

Linear Demand Curve

• Elasticity varies depending on where it is calculated on the curve.

• Example: ε = -0.5(P/Q) at different points on the demand curve:

  • Point A: ε = -99 (very elastic)
  • Point B: ε = -1 (unit elastic)
  • Point C: ε = ? (infinite elasticity)### Elasticity of Demand

• Elasticity of demand varies along a negatively sloped linear demand curve.

• It is high at higher prices and low at lower prices.

• At a certain point (unit elastic point), a 1% change in price causes a 1% change in quantity.

Types of Elasticity

• Unit elastic: a 1% change in price causes a 1% change in quantity.
• Elastic: a small change in price causes a large change in quantity.
• Inelastic: a large change in price causes a small change in quantity.

Perfectly Elastic and Inelastic Demand Curves

• Perfectly elastic demand curve: horizontal, a small change in price has a huge impact on quantity.
• Perfectly inelastic demand curve: vertical, a change in price has no impact on quantity.

Factors Affecting Demand Elasticity

• Availability of close substitutes: if there are several close substitutes, elasticity is high.
• Broadness of product definition: if the product is broadly defined, substitutes may not be close.
• Portion of total budget: if the product represents a high percentage of the budget, elasticity is high.
• Time horizon: if the time horizon is long, elasticity is high.
• Discretionary or non-discretionary nature of the product: if the product is discretionary, elasticity is high.

Relationship between Elasticity and Total Expenditure

• Total expenditure is the total amount a consumer spends on a product (price x quantity).
• In the elastic part of the demand curve, a decrease in price leads to an increase in total expenditure.
• At the unit elastic point, a decrease in price does not change total expenditure.
• In the inelastic part of the demand curve, a decrease in price leads to a decrease in total expenditure.

Introduction to Economics and Demand Analysis

• Economics is divided into two broad areas: microeconomics and macroeconomics.

Demand Analysis

Law of Demand

• As the price of a good rises, buyers will choose to buy less of it (ceteris paribus).
• Conversely, as the price falls, buyers will buy more.

Demand Function

• The demand function expresses the demand for a particular good as a function of multiple variables.
• Key variables influencing demand include the price of the good, income levels, and the prices of other goods.

Example: Demand for Chairs

• Demand function: Q = 10 - 0.5P + 0.06I - 0.01Pt
• Q: quantity of chairs demanded
• P: own price of chairs
• I: average income level
• Pt: average price of tables

Inverse Demand Function

• Can be expressed as: P = 200 - 2Q
• Plotted on a graph, the demand curve shows the highest quantity consumers are willing to purchase at each price.

Elasticity of Demand

• Measures how the quantity of a good demanded responds to changes in its own price, holding other factors constant.
• Formula: ε = (ΔQ/Q) / (ΔP/P)
• For the example demand function, ε = -0.5(P/Q)

Elasticity of Demand Curve

• Elasticity varies depending on where it is calculated on the curve.
• Elasticity is high at higher prices and low at lower prices.

Types of Elasticity

• Unit elastic: a 1% change in price causes a 1% change in quantity.
• Elastic: a small change in price causes a large change in quantity.
• Inelastic: a large change in price causes a small change in quantity.

Perfectly Elastic and Inelastic Demand Curves

• Perfectly elastic demand curve: horizontal, a small change in price has a huge impact on quantity.
• Perfectly inelastic demand curve: vertical, a change in price has no impact on quantity.

Factors Affecting Demand Elasticity

• Availability of close substitutes: if there are several close substitutes, elasticity is high.
• Broadness of product definition: if the product is broadly defined, substitutes may not be close.
• Portion of total budget: if the product represents a high percentage of the budget, elasticity is high.
• Time horizon: if the time horizon is long, elasticity is high.
• Discretionary or non-discretionary nature of the product: if the product is discretionary, elasticity is high.

Relationship between Elasticity and Total Expenditure

• Total expenditure is the total amount a consumer spends on a product (price x quantity).
• In the elastic part of the demand curve, a decrease in price leads to an increase in total expenditure.
• At the unit elastic point, a decrease in price does not change total expenditure.
• In the inelastic part of the demand curve, a decrease in price leads to a decrease in total expenditure.